Edited version of your private advice

Authorisation Number: 1051706906722

Date of advice: 20 July 2020

Ruling

Subject: Small business restructure rollover

Question

Will you be eligible to access the small business restructure rollover relief concession under subdivision 328-G of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

01 July 2020 - 30 June 2021

The scheme commences on:

01 July 2018

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below.

If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You advised that your company, XXXX Pty Ltd operates a dental practice with the XXXX Trust.

You are the sole director and shareholder. You hold all of your shares both legally and beneficially.

The Trust is a discretionary trust with a family trust election naming you as the test individual.

You, the XXXX Pty Ltd and the trust are all Australian residents for tax purposes.

Your aggregated turnover is less than $10 million.

You carry out the XXXX work and engage XXXX. You have accrued goodwill through operation of your practice.

The trust employs XXXX assistants and administrative personnel. It also holds the assets, including plant and equipment, used in the practice.

You own minor depreciating assets used in the practice, but the majority of them are held by the Trust. The Trust charges you a fee for use of the assets.

You stated that as part of a restructure completed on XXXX 2019 the company transferred its goodwill and assets relating to the practice to the trust.

The trust now operates the practice using the assets transferred from the company.

You further advised that at the time of the restructure, there was a desire to collapse the dual entity structure for the practice and consolidate the practice's assets partly because you intended to increase your time spent on other (XXXX related) activities and reduce your hours working as a XXXX. At this stage you were not intending to retire or cease working entirely as a XXXX.

While you did not intend to retire; you intended to increase your time spent on other XXXX related activities and reduce your working hours as a XXXX.

Since commencement of XXXX, you have been diagnosed with a number of health issues which makes the continued operation of the practice in the medium term adverse to your health. As such, you intend to sell the practice.

The restructure was undertaken for the purpose of simplifying the structure of the business and isolate the future business risk of the practice from the private assets that will continue to be held by the passive company.

Relevant legislative provisions

Income Tax Assessment Act 97 section 328-440

Income Tax Assessment Act 97 section 328-445

Income Tax Assessment Act 97 section 328-450

Income Tax Assessment Act 97 section 40-340

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or DPT tax benefit in connection with an arrangement.

If Part IVA applies the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for Decision

These reasons for decision accompany the notice of private ruling for XXXXX.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

Small business restructure rollover

Detailed reasoning

The small business restructure rollover allows small businesses to transfer active assets from one entity (the transferor) to one or more other entities (transferees), on or after 1 July 2016, without incurring an income tax liability.

This rollover applies to the transfer of active assets that are capital gains tax (CGT) assets, trading stock, revenue assets or depreciating assets.

Division 328 of the Income Tax Assessment Act 1997 (ITAA97) sets out a number of tax concessions that are available to a 'small business entity' (SBE).

An SBE is defined in s328-110 of ITAA97. A taxpayer is an SBE for an income year where:

·        it carries on a business in the income year; and

·        one or both of the following applies:

˗        the taxpayer carried on a business in the previous income year and the aggregated turnover for that year was less than $10 million; and/or

˗        the taxpayer's aggregated turnover for the current year is likely to be less than $10 million.

Furthermore, the rollover is available where the transfer of assets forms part of a genuine restructure as opposed to an artificial or inappropriately tax-driven scheme.

Determining whether a restructure is 'genuine' depends on all the facts surrounding the restructure.

To provide certainty to small business owners, a safe harbour rule is included that provides an alternative way of satisfying the requirement that a restructure is genuine.

To be eligible for this rollover, the transaction must not result in a change to the ultimate economic ownership of transferred assets. The ultimate economic owners of an asset are the individuals who, directly or indirectly, own an asset. Where there is more than one individual with ultimate economic ownership, there is an additional requirement that each individual's share of ultimate economic ownership be maintained.

Non-fixed (discretionary) trusts may be able to meet the requirements for ultimate economic ownership, for example, where there is no practical change in which individuals economically benefit from the assets before and after the transfer.

Family trusts may meet an alternative ultimate economic ownership test where:

·        the trustee has made a family trust election, and

·        every individual who had ultimate economic ownership of the transferred asset before the transfer, and every individual who has ultimate economic ownership after the transfer, must be members of the family group relating to the family trust.

As stated in LCR 2016/3 a Small Business Restructure Roll-over (SBRR) can apply to transactions that are, or are part of, a 'genuine restructure of an ongoing business'. Whether a transaction is or is part of a 'genuine restructure of an ongoing business' is a question of fact that is determined having regard to all of the circumstances surrounding the restructure.

A 'genuine restructure of an ongoing business' is one that could be reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business. It can encompass a restructure of the way in which business assets are held where that structure is likely to have been adopted had the business owners obtained appropriate professional advice when setting up the business. However, it is a composite phrase emphasising that the SBRR is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests.

The following features indicate that a transaction is, or is part of, a 'genuine restructure of an ongoing business':

- it is a bona fide commercial arrangement undertaken in a real and honest sense to - facilitate growth, innovation and diversification

- adapt to changed conditions, or

- reduce administrative burdens, compliance costs and/or cash flow impediments.

- it is authentically restructuring the way in which the business is conducted as opposed to a 'divestment' or preliminary step to facilitate the economic realisation of assets.

- the economic ownership of the business and its restructured assets is maintained.

- the small business owners continue to operate the business through a different legal structure.

For example, there is:

· continued use of the transferred assets as active assets of the business

· continuity of employment of key personnel, and

· continuity of production, supplies, sales or services.

Furthermore, when you sell your business, there are CGT concessions available to small business owners. Division 152 of the ITAA97 contains the four small business CGT concessions:

·        15-year exemption - that may exempt a capital gain from a business asset you have owned for at least 15 years

·        50% active asset reduction - that allows you to reduce the capital gain arising from the sale of a business asset

·        retirement exemption - that allows you to receive relief from CGT if you sell assets called active

·        assets used in your business - the exemption does not apply to gains made from passive (investment) assets

·        rollover - that allows you to defer a capital gain from the disposal of a business asset for two years (you can defer the capital gain for longer than two years if you acquire a replacement asset or make a capital improvement to an existing asset).

Section 152-10 of ITAA97 sets out the basic conditions which must be satisfied in order to access any of the concessions. Where the taxpayer passively holds the CGT asset which is used in a business carried on by an affiliate or a connected entity, the affiliate or the connected entity must be a CGT SBE.

The small business restructure roll-over in Subdivision 328-G of the ITAA97 allows an SBE to access a roll-over where the SBE transfers the ownership of its assets without changing the ultimate economic ownership, as part of a genuine restructure. The roll-over disregards the gains and losses that arise as a result of the transfers of CGT assets, depreciating assets and trading stock, and ensures that the restructure is tax neutral.

Under s328-430 of ITAA97 each party to the transfer must either:

·        be an SBE;

·        has an affiliate that is an SBE;

·        is connected with an entity that is an SBE; or

·        be a partner in a partnership that is an SBE.

There are some important taxation considerations for the vendor in selling business assets. While I have mentioned some of them below, it is not an exhaustive list.

Apportionment of the Sale Price

It is important to structure the sale of business agreement with an apportionment of the sale price to the actual assets transferred. Appropriation is the value to each of the assets.

Land and Buildings

Certain pre-CGT assets may be deemed to be post-CGT assets if owned and where the ownership has altered significantly (subdivision 149-B of the ITAA97). Assets acquired after 19 September 1985 ("post-CGT") will be exposed to capital gains tax. A liability to CGT will arise where the consideration for the land exceeds the so-called "cost base" of that asset.

The cost base will, in general terms, include the original cost, plus purchase costs (such as stamp duty and legals). The date for purchase and acquisition for CGT purposes is the date of entry into the contract (section 104-10(3) of the ITAA97).

Buildings on land are treated as separate assets for tax purposes where the land is a pre- CGT asset and the building was constructed post-CGT (section 108-55 of the ITAA97).

Plant and Equipment

Any amount received by the vendor in excess of the tax written down value of plant and equipment (original cost reduced by the amount of depreciation claimed as a tax deduction) will be subject to tax as ordinary income. The depreciable items (plant and equipment) are excluded from the CGT provisions and as a consequence any amount in excess of the written down value cannot be reduced under the small business CGT concessions.

Plant and Equipment Leases

Any premium received by the vendor for the assignment of equipment leases (e.g. where the market value of the equipment exceeds the residual value) will be subject to tax in the hands of the vendor as ordinary income.

Trading Stock

Where the consideration received is less than the original cost of the trading stock then the vendor may claim the shortfall as a deduction on revenue account. The Commissioner has the power to apply "market value" on the sale of stock (section 70-90 of the ITAA97).

Trading stock is excluded from the CGT provisions and as a consequence any amount in excess of the book value cannot be reduced under the small business CGT concessions.

Goodwill

The tax treatment of the sale of goodwill was considered by the High Court in FCT v Murry 98 ATC 4584 (Murry case). The tax concept of goodwill (based on the legal concept) is limited to the extent to which a business owner has the right to defend the business from unlawful competition. The decision in this case limits the amount of value that can be attributed to goodwill for CGT purposes. Accordingly, as per Murry case there is a change in the ability of a vendor to reduce the CGT exposure by allocating value to goodwill on the sale of a business.

Restrictive Covenants

A restrictive covenant is regarded as a separate asset for tax purposes. Any consideration allocated to a restrictive covenant in the sale contract will be subject to capital gains tax. In Murry, the High Court appeared to accept that a restrictive covenant given by the vendor not to compete with the purchaser is similar to an exclusive licence. Namely, the covenant enhances the value of the goodwill of the business and in that sense is taken to be part of the goodwill. The restrictive covenant does not qualify for the Division 115 discount as it is expressly excluded. (section 115-25 of ITAA97)

Application to your circumstances

As stated by you that the roll-over from the SBE to the trust is that the ownership of its assets will not change the ultimate economic ownership in the trust. You also stated that the restructure is part of a genuine restructure. In this circumstance, you may disregard the gains and losses that arise as a result of the transfers of CGT assets to the trust.

Furthermore, for the consequences of Part IV, it is important to note that a successful defence to Part IVA will still fundamentally turn on your ability to provide cogent evidence about your objective purpose in entering into this arrangement. Remember that a subjective assessment of why you entered into a scheme is not relevant. The purpose is determined by a universal consideration of the eight factors in s177D (2) ITAA 1936. The question which you need to consider in a restructuring exercise is whether embarking on a 'series of transactions' you are able to make a further choice under the rollover provisions that would provide a basis for the Commissioner that you have embarked on a scheme.

In an event of sale of the SBE, you may be able to apply the CGT concessions available to small business as per Division 152 of ITAA97, depending on the circumstances at the time of the sale that best reflects your situation. If these concessions do not apply to you then you will be subject to appropriate CGT on the sale.

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